Tuesday, April 27, 2010

More on Financial Regulation


David Brooks gets it right today. Quotes:
"The second big event in Washington this week is the jostling over a financial reform bill. One might have thought that one of the lessons of this episode was that establishments are prone to groupthink, and that it would be smart to decentralize authority in order to head off future bubbles...

But, alas, we are living in the great age of centralization. Some Democrats regard federal commissions with the same sort of awe and wonder that I feel while watching LeBron James and Alex Ovechkin.

The premise of the current financial regulatory reform is that the establishment missed the last bubble and, therefore, more power should be vested in the establishment to foresee and prevent the next one.

If you take this as your premise, the Democratic bill is fine and reasonable. It would force derivative trading out into the open. It would create a structure so the government could break down failing firms in an orderly manner. But the bill doesn’t solve the basic epistemic problem, which is that members of the establishment herd are always the last to know when something unexpected happens."

He mentions something that Mankiw has mentioned before, which is that financial institutions should be forced to issue contingent convertible bonds - in other words, financial firms issue bonds that would be converted to equity when they are deemed to have insufficient capital by a regulator. The important part of this is that traders could buy, sell and short these bonds, and thus you'd have a leading indicator of banking problems.

I LOVE this idea.

I'll add it to the "what I want to see out of banking regulation" list.

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